It was well understood in the 1800s and widely used by U.S. courts during the 20th century, although it has recently declined as Discounted Cash Flow and more direct market-based methods have become more popular.
"Comparable company analysis", closely related, was introduced by economists [citation needed] at Harvard Business School in the 1930s.
These multiples reveal the rating of a business independently of its capital structure, and are of particular interest in mergers, acquisitions and transactions on private companies.
In practice, no two businesses are alike, and analysts will often make adjustment to the observed multiples in order to attempt to harmonize the data into a more comparable format.
These factors, and the existence of wide-ranging comparables, help explain the enduring use of multiples by investors despite the rise of other methods.
Equity price based multiples are most relevant where investors acquire minority positions in companies.
Certain multiples such as EV/EBITDA are also a useful complements to valuations of minority interests, especially when the P/E ratio is difficult to interpret because of significant differences in capital structures, in accounting policies or in cases where net earnings are negative or low.
Important characteristics include: operating margin, company size, products, customer segmentation, growth rate, cash flow, number of employees, etc.
A P/E far below the average can mean (among other reasons) that the true value of a company has not been identified by the market, that the business model is flawed, or that the most recent profits include, for example, substantial one-off items.
Companies with P/E ratios substantially different from the peers (the outliers) can be removed or other corrective measures used to avoid this problem.
They use the following calculation to determine their future value: ((17.95 + 21.7 + 20.8) / 3) * 2,200,000 = €44.3 million Determine the appropriate discount rate and factor for the last year of the forecast period based on the risk level associated with the target company Example: VirusControl has chosen their discount rate very high as their company is potentially very profitable but also very risky.